Stefan Karlsson's blog

Hard-Hitting Economics Commentary

Friday, June 30, 2006

Peter Schiff on the Unavoidable U.S. Recession

Peter Schiff of Euro Pacific Capital have a good article on why a U.S. recession is unavoidable at this point, although he should have also emphasized how over-investments in some areas -particularly housing- will have to be reduced too.

"Now that the Fed has raised rates to 5.25%, and has left the door open for future increases, the overriding concern is that over-tightening will tip the economy into recession. However, given the state of our imbalanced economy, a recession is not only inevitable, but absolutely necessary, and will occur no matter what the Fed does. Furthermore, the coming recession will not come about because the Fed went too far, but because it did not go far enough.

The U.S. economy suffers from extreme economic imbalances that must be resolved. The longer they persist, the more difficult and painful their ultimate resolution will be. The imbalances result primarily from an excess of consumption and borrowing, and insufficient savings and production, and can only be resolved by less of the former and more of the latter. Recession is not the only way to reduce consumption, but since our economy is 70% consumption, any noticeable dip in consumption will lead to recession. The Fed should not prevent this from occurring any more than a clinician at a rehabilitation center should try to prevent a patient from suffering withdrawal by giving him with more heroin.

When the recession occurs it will not be the result of the recent run of Fed rate hikes, but the irresponsible manner in which it lowered them, and kept them low, in the first place. One common misperception is that given the absence of wage pressures, Bernanke is over-reacting to a non-existent inflation threat. However, this naïve view misses the point that rising wages, just like other prices (wages are the price paid for labor), do not cause inflation, but result from it. More importantly, wages usually are among the last prices to adjust upwards in response to inflation, which is one reason that inflation is so damaging. Waiting for an up tick in wages to confirm inflation is analogous to waiting for the caboose to evidence an oncoming train...

...If Bernanke tries to borrow from Greenspan’s playbook and attempts to prevent or mitigate the severity of the coming recession, the excess liquidity will not simply move into another asset class, as it did from stocks to real estate, but into real stuff, such as commodities and consumer goods. As far as the Fed is concerned, it has now reached a monetary divide where all roads lead to stagflation."

Minimum Wages-The Democrat's "Gay Marriage Amendment"

One tactic used by Republicans in 2004 to get their Christian conservative base to go out and actually vote for them was to put the issue of gay marriage on the ballot. By putting the issue on the ballot, their voters would go to the polling station and since they had made the effort to go there they would vote for George W. Bush and their Republican congressional candidates. Although putting this issue on the ballot would presumably increase the willingness of homosexuals to go out and vote for the Democrats, that effect would be small compared to the number of Christian conservatives mobilized for the Republicans. In the key state of Ohio, the higher turnout of Christian conservatives wanting to vote against gay marriage was probably decisive in helping Bush win the state and therefore also the presidency.

The Economist have an interesting article (not online for non-subscribers) in its latest issue about how the Democrats are now planning to use the minimum wage issue as its own "gay marriage amendment". Just like the gay marriage issue is important for a lot more Republicans than Democrats (The number of Christian conservatives in America greatly exceed the number of homosexuals), the minimum wage issue is important to a lot more Democrats than to Republicans. Few Republicans are likely to go out and vote just to stop a minimum wage increase, while quite a lot of Democrats are likely to be mobilized in order to increase the minimum wage.

Realizing this, the Republicans in Michigan for example decided to give in to the Democrats and raise the minimum wage by $1.80 per hours.

Most of my readers are probably aware of the economics of the minimum wage: that although raising it may perhaps mean higher pay for some low-skilled workers, it will make others unemployed.

But the interesting thing about the minimum wage is that at its current federal level of $5.15 per hour, it is at a record-low level in real terms. Already early 2005 did the real level of the minimum wage fall below the low reached just before the 1996 Clinton increase was enacted if deflated by the CPI. And in April this year it fell below that level even using the PCE deflator (a inflation gauge that for various reasons consistently show lower increases than the CPI). And deflated by the CPI, it now fell below the even lower level reached in late 1989, and it is now at its lowest level since the 1950s.

The U.S. minimum wage is also far below that of other countries, with Britain having a £5 minimum wage (nearly $9) and France a €8 ($10) minimum wage.

Because it is so low now, even the Ted Kennedy proposal to raise it to $7.25 per hour by 2009 (when the value of a dollar will of course be even lower than today) will not make much difference in either a positive or negative way.

The drive from Democrats to put minimum wages on state ballots and campaign on the issue is thus similar to the gay marriage and flag burning issues for the Republicans not just because it will disproportionally mobilize the voters of the campaigning side, but also because it really is an issue of no practical relevance for most people. The article in The Economist tellingly reveals how labor unions at first was uninterested in the issue as most of their members have incomes far above minimum wage levels, but when Democratic electoral strategists told them of how this can be a winning issue, they too have started to campaign for a higher minimum wage.

Thursday, June 29, 2006

Thoughts About Warren Buffet's Donation

I have somewhat mixed feelings and thoughts about the news that Warren Buffet have decided to give $37 billionor about 85% of his personal wealth to charity.

On the one hand, at least this means that Warren Buffet is less of a hypocrite than he used to be, as he have for years argued that "the rich" should pay in more taxes. Being rich himself, this would imply that he should while waiting for others to be persuaded of his point of view donate his fortune, which is what he does now. Although, since his agitatation wasn't for people to give away money for good causes but to give it away to the government, he really should have given those $37 billion to the gift contribution department of the Bureau of the Public Debt, and not to the very private "Bill and Melinda Gates Foundation".

Another positive thought about this is that this certainly illustrates that in a society based on voluntary relationships there would be wealthy people willing to donate to people truly worthy of being recipients of aid. No government coercion is needed for that.

The negative thought about this is that it is not really certain that the best help to others billionaires can offer is by giving their money away. It might just have been that had they kept their money and invested them according to their proven wisdom in this area, they might have created more good for others than direct charity would have. What choice will be best for others is not clear and depends on the specific empirical conditions of all cases, but the point is that it is not necessarily the case that charity is the best way to benefit others.

Another negative thought is that the main recipient of this gift will be the "Bill and Melinda Gates Foundation", a foundation who have explicitly racist grounds for its work. It donates money to students, but only to non-white students. Imagine the outcry if they had given scholarships exclusively to white students, or if they had explicitly excluded black students, but since the racial discrimination is directed against whites it is apparently considered acceptable or even laudable.

Wednesday, June 28, 2006

The Damage Caused by Affirmative Action

Interesting NRO article on the politically correct (i.e. anti-white) form of racial discrimination known as "affirmative action" or various other euphenisms.

The article point out that the reason why so few blacks would be admitted to universities without affirmative action is that they on average perform worse, particularly in math and science. And so any colorblind admission criteria would for that reason mean that blacks would be underrepresented (and also to a lesser extent hispanics, while Asians would be overrepresented).

As the article points out, ignoring these facts are not a good solution. Because affirmative action have allowed a lot of unqualified blacks to gain entry, they are far more likely to fail.

"Blacks are two and a half times more likely than whites not to graduate. Blacks are four times more likely to fail the bar exam on the first try and six times more likely never to pass the exam despite multiple attempts.

Perhaps the most astonishing statistic is that only about a third of blacks entering law school this fall will graduate and pass the bar exam on the first try. Bleak are the prospects for many black law students."

This means that affirmative action will not really increase the number of black college graduates by anywhere near as much as it increases the number of black college freshmen.

And even apart from the inherent injustice in better qualified whites being rejected on racist grounds, this mean a hugh waste of resources as a lot of time and money are spent on lesser qualified students who won't make it, creating a significant economic cost for society.

It should be noted that this negative economic effect is likely to come from all forms of "preferential treatment", "affirmative action", "diversity programs" etc. applied both by governments and private companies not only for education but also for contracts and jobs.

Tuesday, June 27, 2006

The Futility of Inflation-Targeting

Read my latest LRC article where I describe why targeting of official consumer price inflation, which is official dogma of most mayor central banks and after Ben Bernanke became Fed Chairman unofficial Fed dogma too, even if desirable (an assumption which can be challenged on many legitimate grounds, but which for now was assumed for the sake of the argument)is a futile endeavor since central banks have almost no influence on the consumer price inflation data they know about, while knowing virtually nothing about the consumer price inflation data they can influence, something which of course makes it impossible for central banks to achieve that target except by pure luck(or statistical manipulation).

A fact which is illustrated by the fact that in recent year Denmark have better achieved the 2% consumer price inflation target than Sweden -whose Riksbank officially targets a 2% consumer price inflation rate- even though Denmark doesn't even attempt to achive it, as it instead pursues a fixed exchange rate policy versus the euro.

Monday, June 26, 2006

Cultures Are Not Equal

Just in case anyone needed proof that the multiculturalist view that all cultures are equal is invalid, just check out this story about how many parents in Cameroon engage in "breat ironing" of their daughters. Really sickening.

Wednesday, June 21, 2006

When Fraud Is Good

EU Observer reports, based on a story in Swedish business website N24 that Chinese textile exporters have learned a way of circumventing EU quotas of Chinese textiles: by simply export it to neighboring countries, especially the "Special Administrative Region" of Hong Kong, who then re-label it and then export it to the EU.

This is of course fraud, but sometimes fraud is justified. And in the case of the unjust EU quotas of Chinese textiles it is definetly justified. This way, poverty in China can be reduced while us EU consumers gain. While some of China's competitors inside and outside the EU may lose, that is a lesser evil compared to increased poverty in China and higher prices here.

Hardly A Coincidence

Drug Prices in America are rising at a record pace, the New York Times report. This happens at the same time as Bush's new Medicare prescription drug benefit goes into effect. This correlation in time is hardly coincidential, as this is just what you could expect from any increase in subsidies. Subsidies of anything will increase demand, something which in turn will of course raise prices.

How Convenient

Yesterday, the Swedish Riksbank raised short-term interest rates to 2.25%, a level which is still unsustainably low considering the rapid monetary expansion it has generated.

Social Democratic party secretary Marita Ulvskog however protested the decision, as did Lars Ohly , leader of the communist Left Party which cooperates with the Social Democrats. To some extent, this reflects the general pro-inflation bias of most leftists. But there is also another motive. This autumn, Sweden holds a general election, which the Social Democrats and their partners, the Left Party and the Green Party risks losing to the centre-right opposition. It is therefore in their political interest that monetary policy remains as loose as possible until the election. Loose monetary policies generally do raise growth in the short run, but in the long run the effect will likely be negative. But because voters are generally myopic in their assessment of the economy, the short-term boost before the election will in political terms for the ruling party be worth the negative long-term effects, even if the latter are much greater.

Never have the political bias in a interest rate recommendation been more obvious than in the latest commentary from Konjunkturinstitutet (The Business Cycle Institute)-a government agency led by Social Democrat Ingemar Hansson. They recommend that the Riksbank abstain from any further rate increases this year, only to be followed by dramatic interest rate hikes starting next year.

Note here that they don't even dispute the need for a "tighter" monetary policy-they just think it should be done after the election. From a politically neutral point of view, the rate hikes should come ASAP, to prevent a dangerous build-up in debt. Are we then to believe that the recommendation from a government agency led by a Social Democrat to wait until after the election is not motivated by a political bias?

Tuesday, June 20, 2006

More On Swedish "Success" Hoax

Johnny Munkhammar and Tino Sanandaji presented yesterday a report (In Swedish), exposing the lies from Swedish Social Democrats and others about the alleged Swedish success, with regards to growth, employment and unemployment in general and employment and unemployment for immigrants.

With regards to growth, they point out like I did that it is misleading to use 1994 as a base year since Sweden then was just starting to recover from the by far deepest recession since the 1930s, and so there was a very strong cyclical element in the economic growth in the mid-1990s. Moreover, they also point out as I that even with that base year growth was only about average after you adjust for terms of trade which is important for reasons explained here. Most EU countries have (until the recent surge in the price of imported oil) in fact seen their terms of trade improve, whereas Sweden have seen its worsen significantly.

The most relevant comparison would be one where one included the recession of the early 1990s, and not just the cyclical recovery that followed after it, and then you can see that Sweden have actually performed even worse than the average of the old EU countries. Another alternative base year, 1999 (which exclude both the recession and recovery of the 1990s), show roughly the same result.

The one slightly unsatisfactory part about the section of growth is their account of the much stronger growth that seems to occur this year, where they write that it is an open question as to whether this will be the beginning of a new trajectory of higher growth or a single year of cyclical boom caused by fiscal stimulus remains unclear. While the small tax cut certainly have helped somewhat, it is not by itself sufficent to significantly lift either the long-term structural or short-term cyclical growth of the Swedish economy. Instead, the main reason for the higher growth this year is monetary stimulus, with interest rates being lowered a year ago to an all time low of 1.5%, something which set into motion a surge in money supply and bank lending growth even higher than in the Euro-zone (that saying a lot). Moreover, by weakening the exchange rate of the krona, it also temporarily stimulated exports. While interest rates have started to rise again now, it have not done so faster than in the Euro-zone and so monetary policy is still even more stimulative/inflationary than in the Euro-zone.

The section about job growth show a similar theme, with the Social Democrats disingenously using 1994 or 1995 as a base year. Using more relevant base years like 1985 or 1990 shows that employment have fallen significantly relative to population (and in the latter year even before adjusting for population growth).

The section about unemployment reiterates what I have previously written about how the Social Democrats have misleadingly hidden unemployment in various programs designed to hide unemployment. They argue based on their estimate of how many of early retiress etc. which are truly sick that true unemployment is 17%. That (which they acknowledge) however probably understates true unemployment as it based on very conservative estimates (for example they assume that none of early retirees in 1991 could work) on how big a proportion of early retirees and people on sick leave could work. Using a more reasonable methodology, which would argue that all who are not severely disabled could work with something, you would rather get the 20-25% which I refered to in "Does Sweden Defy Economic Logic?".

They also rightly point out that it is not reasonable to compare -as Swedish Social Democrats often do- the people in Sweden who are payed not to work with stay at home mothers, which due to feminism have become rare in Sweden but is still common in other countries. Even if you adhere to the feminist belief that stay at home moms are reprehensible collaborators with the patriarchial enemy, it must be acknowledged that women who take care of their own children are working just as much as women who take care of other people's children.

Regarding the issue of immigrant unemployment they make the same points that I made here.Namely, that the claim by Agency of Integration boss Andreas Carlgren that Sweden have a relatively high level of immigrant unemployment reflects first of all that immigrant employment levels is exaggerated in official statistics for the same reasons mentioned above as to why overall employment levels are exaggerated and secondly that this number includes a high proportion (higher than in most other countries) of Western immigrants. For non-Western immigrants, true unemployment is catastrophically high, at more than 50% for many immigrant groups like Somalis.

Overall , apart from the interpretation of this year's Swedish growth number, the report is very good. It remains to be seen whether or not journalists and opposition politicians will use it to stop accepting the constant lying by Pär Nuder and other Social Democrats.

Not only will this be a demand side boost, but it will more importantly reduce the disincentive for domestic division of labor through a more advanced service sector. All taxes on economic transactions, whether it be VAT, income taxes or payroll taxes function as tariffs on domestic division of labor, and cutting them will for that reason help boost the domestic economy just as cutting tariffs on international trade will help boost international trade.

Of course, this will not be enough to significantly reduce Israel's income gap versus North America or Western Europe, as the fundamental problem for Israel's economy, that so many of its citizens -particularly its Arab and ultra-Orthodox Jewish citizens- wholly or partially lives of the welfare state. But still, it will certainly help and barring a dramatic increase in Palestinian terrorism or a dramatic downturn in the global high tech sector, Israel will helped by this tax cut likely continue to have higher growth than Western Europe and America for the coming years.

Saturday, June 17, 2006

New Evidence of Failure of Bush Education Policy

In April I reported about how Bush's "No Child Left Behind" program which formally requires schools to improve test scores have led to increased test score deception.

Now a new Harvard study confirms this and also shows that there is no evidence of improved skills among American students, "despite" the vast amount of money spent and the increased federal control over American schools. The study notes that states are allowed to choose what tests to use in order to determine whether student results are improving and according to the tests which each states have chosen, results have improved.

Yet according to the independent test administerd by the National Assessment of Education Progress (NAEP), results are not improving, suggesting that the tests used by the states in order to escape penalties are manipulated.

Nor have the other stated goal of Bush's education plan, reducing the racial gap in achievement, been reached.

Friday, June 16, 2006

Euro-zone Inflation Forecasted to Be Above 2% Until 2009

Financial Times report that the ECB forecast Euro-zone inflation will remain above 2% until at least 2009.

I am somewhat skeptical to say the least of the possibility of predicting consumer price inflation numbers so far into the future. Still though, it seems more likely than not that this forecast will come true given the far too high money supply growth and the weak structural growth potential of most Euro-zone economies.

What is interesting is that this forecast comes from the ECB. If they themselves believe this, why didn't they raise by more than a measly quarter point at the last meeting and indicate more clearly that more hikes are on the way? It is beyond me how anyone could consider the ECB to be inflation hawks.

Accelerating Chinese Growth Strengthens Case For Yuan Revaluation

Numbers for May that have come out so far from China suggests that growth in the second quarter will be even higher than the 10.3% growth rate in the first quarter. The trade surplus rose to $13 billion from $9.5billion in May 2006, despite extremely fast increases in domestic demand. Retail sales rose 14% in nominal terms or 12.5% in real terms while urban fixed asset investments rose 30.3%. Industrial production growth therefore accelerated to 17.9%, the fastest in years.

This mainly reflects the impressive structural strength of the Chinese economy created by the extremely high savings rate and the abundance of workers coming in from rural areas. Yet it clearly also reflects a too high rate of monetary expansion, with M2 money supply increasing 19.1%.

The Chinese authorities are well aware of the risks that this poses and have tried to tighten somewhat. Yet because of the widespread expectation of continued yuan appreciation, interest rate hikes are of limited value as the reduction in loan demand it would create would be partly offset by increased capital inflow.

Another measure which the Chinese authorities could do and most likely will do is various administrative controls to limit credit to overheated sectors. This is exactly what they did today, when they ordered banks to increase their reserves. This will certainly do some good, yet experience shows that local authorities sabotage such measures to some extent and secure credit for such projects in defiance of Beijing.

Another thing which they could do and have actually said they will do to a limited extent is to reduce barriers for Chinese individuals to invest outside of China. But this is likely to have limited effect, particularly in the modest form so far proposed.

The best and most effective way, particularly if combined with the above measures, would be to significantly revalue the yuan. A higher current exchange rate for the yuan would reduce appreciation expectations and thus reduce the capital inflow that is the main reason for today's overheated economic conditions. Moreover, by reducing profitability in capital intensive export industries to more labor intensive domestic sectors, it would reduce loan demand. Unfortunately, the Chinese authorities don't seem to get that. While the yuan did rise above level of 1/8 dollar Wednesday, that is far too little.

Thursday, June 15, 2006

Financial Times: Sweden's Real Jobless Rate 15%

Via Munkhammar I see that Financial Times have an article about Sweden, pointing out that the real unemployment rate is far higher than the official 5-6%. The article puts the number at 15%. This is actually a low estimate though, as many other measures based on the number of people who receives payment from the Swedish government not to work is more like 20-25%.

Wednesday, June 14, 2006

So Now It's Core Core Inflation?

Friday, June 09, 2006

The "Gay Marriage" Red Herring

President Bush is not popular these days. There are many reasons for this. Despite the recent good news of the killing of terrorist leader Abu Musab al-Zarqawi, Iraq is a big mess now, with high financial and human costs for America and seemingly no end in sight. Economic growth have stayed at a fairly high rate, but because of rising inequality and higher gas prices, most ordinary Americans do not feel that their economic situation is improving. Meanwhile, Bush's conservative base is angry with him because they feel he spends too much and because they do not like his proposed amnesty/guest worker scheme for illegal immigrants.

While Republican Brian Bilbray won a recent election of a House seat in California, this was after trying to disassociate himself from the President, particularly on immigration. But despite this and despite the incompetence and repulsiveness of the Democrats, the Democrats still looks set to make big gains in November's congressional election, maybe even taking over one or both of the two chambers of Congress.

It is in this context we should see Bush's strange push for a constitutional amendment to ban gay marriage. It might seem puzzling that he would spend so much time on it because 1) He have never cared about the issue before apart from -not coincidentally- during the previous election 2) Since it is Congress and State legislatures who decides on this issue and not the President, he really don't have much influence on the issue 3) It was well-known that there was no way it would get the required 2/3 in the Senate.

So why did he do it? Simply because he know that this will mobilize his conservative base, who on religous grounds are obsessed with the for all rational people uninteresting and irrelevant issue of whether or not homosexuals can call themselves married or not. It was largely the desire of Christian fundamentalists to prevent "gay marriage" who helped Bush get re-elected in 2004, so now he tries to do it again.

Eastern European Growth Accelerates Further

One of the reasons for the unusual strength of the Swedish economy during the first quarter -together with tax cuts and interest rate cuts- was that exports increased strongly during that period. And it increased particularly much to Eastern Europe. While total Swedish exports increased 20% in nominal non-seasonally adjusted terms during the first quarter, exports to Eastern Europe increased particularly much. Exports to Estonia for example, increased a full 64(!)% and exports to Slovakia increased 62%. Export growth to other Eastern European countries was somewhat more moderate, but still way above the overall average, with exports to Latvia increasing 28%, to Lithuania 50%, to Poland 27%, to the Czech Republic 32% and to Slovenia 29%. The only exception to this general tendency was the 3% decline in exports to Hungary.

So, Sweden have been enjoying windfall gains from Eastern Europe's boom. And while Sweden's 4.1% growth was impressive by historical Swedish and Western European standards, it is pathetic compared to Eastern Europe's growth.

A few days ago, Estonia reported that first quarter growth was a full 11.6% and before that Lithuania reported 8.8% growth. Latvia , we learned today had an incredible 13.1% growth rate.

As Bloomberg News reports, while the other new EU member states have slower growth than the Baltic states, they are still all growing a lot faster than Sweden and the other Western European countries (With the possible exceptions of Ireland and Luxembourg). The Czech Republic , for example, had 7.4% growth, Slovakia had 6.3% growth, Poland and Slovenia both had 5.1% growth while Hungary had 4.6% growth.

To some extent, these growth numbers are cyclical to their nature as monetary policy is far too loose. All except Poland, the Czech Republic and Hungary have fixed exchange rates versus the euro and for that reason is forced to adopt the ECB:s far too loose monetary policy. And as the Bloomberg News article states, Czech monetary policy is in some aspects even looser.

Still, it is clear that the underlying structural growth rate is far higher than in Western Europe too. Both because they have lower initial income and because they pursue sounder microeconomic policies with low taxes in general and low corporate income taxes in particular. So, we should expect Eastern Europe to continue to outperform.

Wednesday, June 07, 2006

Strong First Quarter Swedish GDP Growth-But It Won't Last

Today's report (As usual more details in the Swedish language version ) on first quarter GDP in Sweden came in roughly as strong as I expected it, at 4.1%. Given the surprise increase in the trade surplus and the strong retail sales numbers, a growth rate of roughly this magnitude was to be expected. The details are actually mostly good with the trade surplus rising and business investments increasing at a double digit rate, while government purchases rose a lot more slowly than private sector production. As we shall see however, future prospects are not as good.

As one could have expected, Swedish Finance Minister Pär Nuder gloated about the number, repeating his old lie about how this mean Sweden have the highest growth rate. While this claim was now actually somewhat closer to the truth than in the past, both because he modified it to being the highest in EU15 (i.e. excluding the Baltics and other rapidly growing Eastern European countries) and because Sweden with this number surpassed Spain and (by a mere 0.1%:point) Greece, it is still lower than in Denmark, Ireland and Luxembourg.

As increasing inflationary pressures will soon force the Riksbank to follow the Fed and the ECB and hike interest rates substantially. And because Sweden have lower interest rates and higher money supply growth than the Euro-zone, the Riksbank will have to tighten more, meaning that we can expect the Swedish economy to cool more than in the rest of Europe.

Moreover, there are signs that growth have already decelerated. April employment growth was , as preiously reported very weak. And while investment growth was reported at 12% for the first quarter, a business survey indicates that manufacturing investment growth for the year will be a far more moderate 5%. Even counting in the higher expected growth rate in residential investments, the survey clearly indicate that investment growth will slow substantially during the rest of the year.

So it is nearly certain that growth will slow, both in absolute and relative (compared to rest of Europe) terms during the rest of the year. Whether it will slow fast enough to deprive the Social Democrats of re-election in this September's election is however less clear.

UPDATE July 13th: Now I see that Greek growth have been upwardly revised to 4.1%, meaning that just 10 out 14 of the old EU countries have lower growth than Sweden.

Tuesday, June 06, 2006

Bernanke-Hawk or Black Hawk?

Monday, June 05, 2006

Short-Term Bullish And Long-Term Bearish News For Japan

Today it was reported that capital spending by Japanese companies rose a full 13.9% at an annual rate in the first quarter of 2006 compared to the previous quarter. This was much higher than was assumed in the preliminary estimate of first quarter GDP and assuming zero net changes in other components, this will raise overall volume growth from 1.9% to 3.2%.

The longer term outlook for Japan looks weaker though, as it was reported that the fertility rate of Japanese women fell to an all-time low of just 1.25 children per woman. Although this is higher than in neighboring South Korea, where the fertility rate fell as low as 1.08 children per woman last year, that is much lower than in most Western countries, even though they with the exception of the United States, New Zealand, Ireland and Iceland all have fertility rates lower than the 2 cildren per woman needed to maintain a stable population in the long run.

This low fertility rate will mean that the ageing of Japanese society -who already have the world's highest median age- will accelerate further. This need not mean a lower standard of living assuming that average retirement age is raised along with the median age, and Japan have in fact been much better than Western countries with a particularly high median age like Italy and Germany in keeping its old people in the work force. But even if it does not necessarily mean a lower per capita income, it will certainly mean that the relative influence of Japan in the world economy will diminish.

Saturday, June 03, 2006

Why The ECB Needs To Go For 50

On June 8, the ECB Governing Council will meet in Madrid to decide the next move in interest rates. That they will raise is at this point more or less a foregone conclusion. What will be interesting is how much they will raise and how "hawkish" their comments after the meeting is going to be. The general expectations is for a 25 basis point hike, and I agree that this is the most likely decision. However, it should be noted that when asked about a 50 basis point hike, ECB council members have not explicitly ruled it out. This is interesting as they have not hesitated to rule out certain moves in the past, like in early April when Jean-Claude Trichet explicitly ruled out a May interest rate hike. The ECB have thus made it clear that both a 25 basis point hike and a 50 basis point hike is possible.

The case for raising by 50 basis points is really owerwhelming. As I pointed out in a recent post money supply and private sector debt growth have increased to record high levels, while consumer price inflation have risen to 2.5%. Moreover, as is pointed out in a Morgan Stanley comment on the issue, producer price inflation have risen to 5.4% while inflationary expectations have risen sharply. Even so-called "core" consumer price inflation have accelerated recently.

In the latest Credit Bubble Bulletin from Prudent Bear, it is also reported that house price inflation 'continues to be unreasonably high in Ireland, where prices rose 1.4% the last month and 13.2% over the last 12 months, with prices now being on average nearly €300,000.

And with falling unemployment and above trend growth, even the "weak economy excuse" is now removed.

The ECB have already done enough damage by keeping short-term interest rates negative in real terms for more than two years and then raising them at a snail's pace. Continuing to drag its feets over this issue by only raising a measly 25 bp will only further aggravate the imbalances this policy have already created.

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